Kosmos Energy Ltd. quarterly report, Q2 FY2012

Kosmos Energy Ltd. — Q2 2012 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2012. Financial statements are unaudited. Kosmos is an independent oil and gas exploration and production company focused on frontier and emerging areas in Africa and South America, with production from Ghana’s Jubilee Field.

Financial performance and position

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Oil and gas revenue	$112.2 million	$124.1 million	$228.0 million	$216.7 million
Net loss	$24.8 million	$9.1 million	$62.4 million	$63.7 million
Operating cash flow	Not stated for the quarter	$160.7 million	$54.5 million
Investing cash flow	Not stated for the quarter	$(194.2) million	$(119.5) million

• Q2 oil sales were 997 thousand barrels, approximately unchanged from 996 thousand barrels a year earlier. Average realized price fell to $112.60 per barrel from $124.62. First-half sales were 1.928 million barrels at an average $118.25 per barrel.
• Q2 production costs were $19.6 million, including $10.3 million of workover costs; depletion and depreciation were $33.0 million. Combined production and depletion costs were $51.05 per barrel, versus $36.16 a year earlier. First-half combined cost was $45.78 per barrel versus $39.49.
• Cash and cash equivalents were $630.0 million at June 30, down from $673.1 million at year-end. Current assets were $938.7 million and current liabilities $248.1 million. The filing reports $23.0 million of current restricted cash and $3.8 million of long-term restricted cash.
• Debt was $1.110 billion, with $50.0 million of unused borrowing-base availability; the company reported net debt of $480.0 million and cash plus unused availability of $680.0 million. The facility matures March 2018, with scheduled amortization beginning in 2015 under the stated borrowing assumptions.
• Net derivative liabilities were $25.3 million. The filing does not provide a clear consolidated gross-margin or EBITDA figure.

Material changes versus comparable periods

• Q2 revenue declined $11.9 million year over year, principally because of lower realized oil prices; volumes were nearly flat. First-half revenue rose $11.3 million, primarily on higher realized prices.
• Q2 exploration expense fell $68.3 million year over year, reflecting substantially lower unsuccessful-well costs. First-half exploration expense declined $37.1 million.
• General and administrative expense rose $15.0 million in Q2 and $41.1 million in the first half, mainly due to higher equity compensation and staffing. Equity-based compensation was $38.9 million for the first half, versus $9.1 million in 2011.
• First-half operating cash flow increased, primarily because of timing of oil receipts and other working-capital movements; the cash-flow improvement should not be read as solely earnings-driven.
• Q2 net loss widened despite lower exploration costs, reflecting lower revenue, higher production and depletion costs, higher G&A, and $22.5 million of income-tax expense. First-half net loss was broadly similar to 2011.

Outlook, commentary, risks and unusual items

• Management estimated 2012 capital expenditures at approximately $500 million: about 45% for development and 55% for exploration, appraisal and new ventures. The estimate was reduced after the company removed planned Jubilee sidetracks and updated WCTP appraisal plans. Actual spending depends on drilling results and other assumptions.
• Jubilee Phase 1A development plan approval was received in January 2012; it includes eight additional wells. Three Jubilee wells underwent acid-stimulation workovers during Q2.
• Management reported that Ntomme-2A testing confirmed oil-bearing reservoir continuity. A July 2012 Wawa-1 discovery encountered gas-condensate and oil-bearing pay. Teak-4A encountered non-commercial reservoirs and was plugged and abandoned; $15.8 million of well costs were expensed through June 30.
• Exploration and appraisal outcomes remain uncertain. Several Ghana discoveries had commerciality decisions pending, and the Mahogany development plan remained under discussion with Ghanaian authorities. Kosmos also disclosed an ongoing dispute concerning the Cedrela prospect and relinquishment rights in part of the WCTP Block.
• New Mauritania petroleum contracts were gazetted in June, with an estimated $12.6 million of work commitments. A proposed Morocco interest acquisition and the Suriname farm-down to Chevron remained subject to required approvals or processes.
• In July, after quarter-end, Kosmos entered 2013 three-way oil collars covering 1.5 million barrels, with a $95 floor, $105 ceiling and $125 call price. It also designated an additional $27 million as restricted cash for performance guarantees.
• Income-tax expense was unusually high relative to pre-tax results; management attributed the elevated U.S. effective tax rate partly to differences between tax deductions for vested stock awards and compensation expense recognized for financial reporting. The filing also notes a prior-year material weakness in tax-provision controls, which management said had been remediated; disclosure controls were judged effective at June 30.
• The company said it was in compliance with debt financial covenants based on its April 19, 2012 forecast. Key risks include oil-price volatility, exploration and development execution, access to financing, country and regulatory risks, and availability and cost of rigs, services and infrastructure. Management reported no material off-balance-sheet arrangements and no litigation matters expected to materially affect the financial statements.

Important facts for investors to verify

• Whether Jubilee production, realized prices and workover activity support the expected cash generation and approximately $500 million 2012 capital program.
• The timing and outcome of Ghanaian commerciality decisions, the Mahogany plan discussions and the Cedrela/WCTP rights disputes.
• Whether the $50 million borrowing-base availability and covenant compliance remain adequate as capital spending continues; facility availability is subject to borrowing-base redeterminations.
• The drivers and cash-tax implications of the reported tax provision, and the effectiveness of the remediation of the prior tax-control weakness.
• How pending government and partner approvals affect the Morocco and Suriname transactions and the company’s planned exploration timetable.